Strong Creditor Rights Research Articles

Geopolitical conflict and firm bankruptcy risk

This study examines the impact of geopolitical risk on corporate bankruptcy. We utilize a global dataset of 36,802 firms from 42 countries covering 2004-2022. Our baseline result indicates that geopolitical risk increases firm bankruptcy risk. Our results remain robust after controlling for endogeneity using 2SLS, propensity score, and entropy balancing techniques, as well as using alternative proxies. Our analysis shows that high cash flow and strong creditor rights help mitigate bankruptcy risk, while high leverage and aggressive earnings management stimulates it. Our findings provide insights for policymakers and industry practitioners to formulate effective strategies to mitigate bankruptcy risk in globalization.

Creditor enforcement and accounting quality: A natural experiment

The SARFAESI Act of 2002 strengthened creditor enforcement rights in India by granting banks broad new powers to enforce claims against delinquent secured borrowers. Using a difference-in-differences design, I find that firms with high levels of secured borrowing (i.e., treated firms) exhibit an improvement in accounting quality post-reform. The main findings are especially stronger among smaller firms and firms not affiliated with business groups. I also document significant cross-sectional variation in the main results based on borrowers' financial constraints and banking relationships. These findings are consistent with banks increasing monitoring of borrowers under a stronger creditor rights regime. Overall, this study provides new evidence that stronger creditor rights translate to higher accounting quality.

Creditor rights, corruption and capital structure: Evidence from emerging markets

This paper investigates the impact of creditor rights on the relationship between corruption and capital structure. We hypothesize that creditor rights can mitigate the impact of corruption on capital structure. The data consists of 17,114 firms listed in 24 emerging countries during the period from 2012 to 2020. Our setting of emerging countries can be an interesting context because firms in these countries may rely more on debt than equity. In these countries, the corruption may be more severe and thus we expect that the impact of corruption on corporate capital structure may be more prominent. Using a pooled ordinary least square (POLS) regression model, we find that firms tend to use more leverage in countries with a high level of corruption. However, this relationship can be weakened in strong creditor rights countries. This result does not change when we employ random effects and fixed effects models. The results of this study imply that policymakers should consider improving the degree of creditor rights if they want to deal with the high level of corruption in a country.

Creditor rights, bank competition, and stability: International evidence

The paper exploits changes in bankruptcy laws in 15 countries to analyze the effect of creditor rights on bank competition and stability. I find that stronger creditor rights in bankruptcy increase bank competition, especially in countries with less stringent restrictions on bank entry and non-traditional bank activities. The increase in bank competition lowers bank stability and counteracts other positive effects of stronger creditor rights on bank stability through higher recovery rates. Empirical analysis controls for changes in creditor rights outside bankruptcy and the results are robust to alternative specifications, alternative sample definitions, and omitted variables and endogeneity controls.

Stock market, credit market, and heterogeneous innovations

AbstractThe relative importance of credit market development and stock market development in boosting innovation remains a long‐standing debate issue. In this study, we document how different types of financial markets development affect heterogeneous innovations. Using a broad sample across 42 developed and emerging economies and a generalized difference‐in‐differences identification strategy, we find that stock market development leads to significantly higher substantive innovation, especially in young and small firms, but has negative impact on incremental innovation. Conversely, credit market development promotes incremental innovation, especially in mature and large firms, but has negative impact on substantive innovation. Further analyses indicate that stronger shareholder protection enhances the positive impact of stock market on substantive innovation, while stronger creditor rights enhance the promoting effect of credit market on incremental innovation, and even turn the negative impact of credit market on substantive innovation into positive. Our paper provides new insights into the heterogeneous effects of credit market and equity markets on the real economy.

How do stronger creditor rights impact corporate acquisition activity and quality?

We exploit a quasi-natural experiment (the adoption of state anti-recharacterization laws) to study the effect of strengthened creditor rights on corporate mergers and acquisitions. We find that, following the passage of anti-recharacterization laws, firms decrease overall acquisition activities. This effect is stronger for firms with worse agency problems. Announcement returns to shareholders are larger and post-merger operating cash flows are better for acquirers with weaker governance. Furthermore, returns to bondholders of these firms are also higher, indicating no wealth transfers. Taken together, our evidence suggests that ex-ante strengthened creditor rights can discipline firm managers to reduce value-destroying acquisitions and conduct higher quality deals.

Inflexibility and corporate innovation: Cross-country evidence

Employing an international sample from 25 economies, we investigate the relationship between firm-level scale inflexibility and corporate innovation. The baseline result shows that inflexibility is positively associated with innovation activities. In the mechanism analyses, we find that the positive relationship is mainly driven by firms with higher contraction inflexibility and in less stable external environments. The positive relationship is also stronger for firms in industries with higher concentration, and in economies with stronger creditor rights. Finally, we observe a weaker relationship in multinational enterprises. Collectively, our findings suggest that scale inflexibility creates a stable environment for corporate innovation.

The signaling role of covenants and the speed of capital structure adjustment under poor creditor rights: Evidence from domestically and cross-listed firms in Brazil

This paper studies how covenants affect the speed of capital structure adjustment in Brazil, an environment with poor creditor rights. Unlike previous evidence for developed countries, we find that the existence of debt covenants increases the speed of capital structure adjustment by more than 20% for firms that are only domestically listed. For firms that are cross-listed in the US, this effect is smaller (if any), possibly because these firms “bond” to the stricter regulation and creditor protection of the US market. Our results suggest that in emerging markets with poor creditor protection, covenants are an imperfect substitute for strong creditor rights and employed as a signaling device, permitting firms to adjust their leverage towards optimal levels quicker.

Do Country-Level Creditor Protections Affect Firm-Level Debt Structure Concentration?

AbstractWe study the effects of country-level creditor protections on the firm-level choice of debt structure concentration. Using data from forty-six countries, we show that firms form more concentrated debt structures in countries with stronger creditor protection. We propose a trade-off framework of optimal debt structure and show that in strong creditor rights regimes, the benefit of forming concentrated structures outweighs its cost. Because strong creditor protections increase liquidation bias, firms choose concentrated debt structures to improve the probability of successful distressed debt renegotiations. Firms with ex ante higher bankruptcy costs, including those with higher intangibility, cash flow volatility, R&D expenses, and leverage, exhibit stronger effects. Firms with restricted access to capital are also affected more. A difference-in-differences analysis of firms’ debt structure responses to creditor rights reforms confirms the cross-country results. Our findings are robust to alternative settings and a battery of robustness checks.

The ex‐ante Effect of Law and Judicial Efficiency on Borrower Discouragement: An International Evidence

AbstractWe investigate whether cross‐country differences in the legal system influence demand‐side credit constraints. We explore the notion of discouraged borrowers — firms that choose not to apply for bank credit because they anticipate rejection. Employing survey data from 46 economies, we find that rapid and less costly court proceedings, lower procedural complexity in court processes, and higher recovery rates under bankruptcy lead to the lower likelihood of borrower discouragement. These results are more pronounced in countries with strong creditor protections in relation to company reorganization and liquidation. The results corroborate the supply‐side view that strong creditor rights and their efficient enforceability alleviate banks’ participation constraints in the loan market, thereby encouraging small and medium‐sized enterprises to apply for credit in the first place. We also find that differences in institutional settings, such as higher regulatory quality, better control of corruption, and the rule of law, lead to lower rates of credit self‐rationing in the loan market.

Creditor Rights, Access to Finance, and Corporate Social Responsibility: Evidence from a Natural Experiment

Using difference-in-difference approach, we find that strengthening creditor rights, after the staggered enactment of anti-recharacterization laws that enhanced the ability of creditors to repossess collateral during bankruptcy, leads to higher CSR and improves CSR strengths and CSR areas that directly relate to firms’ primary stakeholders. Stronger creditor rights lead to more corporate social performance in financially constrained firms and in those with increased post-shock debt financing and risk taking. Our new evidence suggests that stronger creditor rights increase CSR of firms that value external financing, shifting the attention more squarely to access to finance as a driver of CSR and points that strengthening stakeholders’ rights and relaxing the financial constraints of firms can lead to improved CSR.

Public family firms and capital structure: A meta‐analysis

AbstractResearch Question/IssueIn this study, we examine the impact of family firm status on publicly listed firms' leverage ratios. Furthermore, we investigate the moderating role of a country's institutional setting, especially its shareholder and creditor rights, on this relationship.Research Findings/InsightsConducting a meta‐analysis on 869 effect sizes from 613 studies, we find an overall slightly negative but significant relationship between family firm status and leverage. Our results reveal a large amount of heterogeneity and considerable mean effect size differences across the 48 countries included in the study. The results of our meta‐regression analysis reveal significant moderating effects of shareholder and creditor rights on family firms' capital structure decisions. Whereas stronger shareholder rights have a positive impact on family firm leverage, stronger creditor rights have a negative impact.Theoretical/Academic ImplicationsOur study combines the two dominating and competing views on family firm leverage. On the one hand, the overall lower leverage ratio of family firms confirms the risk‐aversion view of family firms. On the other hand, control considerations also have a significant impact on leverage ratios, as family firms adjust their capital structure dependent on shareholder and creditor rights in their home country. Our study highlights the importance of the institutional setting on firms' financing patterns.Practitioner/Policy ImplicationsThe results suggest a significant impact of a country's institutional setting in general, and its strength on shareholder and creditor rights in particular, on family firms' capital structure decisions. Control considerations result in a strategic use of debt financing that ensures the owner family's dominant position in the firm and prevents potentially harmful conflicts with minority shareholders or creditors.

A Theoretical Framework for Law and Macro-Finance

What role (if any) should the design of the legal protections of creditors in bankruptcy law play in the regulatory frameworks for financial markets? In this paper, I consider the effects of such protections within the macro-financial theory of leverage cycles of John Geanakoplos. The central tenet of the theory is that leverage is procyclical. That effect exists because creditors tend to lend more in a credit boom, when their expectations for asset returns are optimistic than in a credit bust, when their expectations are pessimistic. I find that strong creditor rights have strong procyclical effects. In a credit boom, when expected asset returns are higher, leverage decreases, creating incentives for creditors to underwrite additional leverage without a substantial impact on its price. The stronger the rights, the more certain recoveries and, as a result, the incentives to underwrite additional debt. By creating such incentives, strong legal protections of creditors exacerbate the credit boom. In contrast, in a credit bust, when expectations for asset returns are pessimistic, strong creditor rights have procyclical effects because they incentivize creditors to force deleveraging or foreclose to maximize recoveries. On the positive side, the framework explains why countries with stronger creditor rights are more likely to experience a violent credit boom. On the normative side, the policy implication is that, in limited circumstances, the strength of creditor rights should be designed in a countercyclical fashion. Through a countercyclical design of creditor rights, policymakers should encourage creditors to lend into a credit bust but discourage them from lending into a credit boom. Recognizing the practical challenges of countercyclical adaptations of the strength of creditor rights, this paper suggests an alternative time-invariant regulatory framework implementing strict limits on leverage on all actors of the economy, from sovereigns, through banks, firms to households. The goal of the framework is to limit credit booms and smoothen the economic cycle.

The Effect of Creditor Rights on Corporate Leverage and Investments: The Role of the Firm Type

Stronger creditor rights reduce credit costs and thus may allow firms to increase leverage and investments, but also increase distress costs and thus may prompt firms to lower leverage and undertake risk-reducing but unprofitable investments. Using a German bankruptcy law reform, on average, we find evidence consistent with the latter. We also hypothesize and find evidence that the effect of creditor rights depends on the firm type (most importantly, the firm size), as it influences the effect of creditor rights on credit costs and distress costs and thus which effect outweighs. Our understanding not only reconciles the mixed empirical evidence of existing studies, but also has important implications for optimal bankruptcy design. In particular, it points to a menu of procedures in which a debtor-friendly and creditor-friendly procedure co-exist and thus allow different types of firms to utilize the prevailing overweight.

How Do Stronger Creditor Rights Impact Corporate Acquisition Activity and Quality?

We exploit a quasi-natural experiment (the adoption of state anti-recharacterization (AR) laws) to study the effect of strengthened creditor rights on corporate mergers and acquisitions (M&A). We find that, following the passage of AR laws, firms significantly reduce M&A activities. This effect is stronger for firms with higher bankruptcy risk. Conditional on making an acquisition, M&A announcement returns to both shareholders and bondholders are larger for acquirers with high bankruptcy risk, indicating no evidence of wealth transfers. Our evidence suggests that ex-ante strengthened creditor rights prompt firms to conduct more value-enhancing deals.

One Man's Gain is Another's Pain: The Effect of Strengthening Creditor Rights on the Cost of Equity Capital

Using the difference-in-difference approach, we find that the staggered enactment of anti-recharacterization laws, which strengthened creditor rights by enhancing the ability of creditors to repossess collateral during bankruptcy, leads to lower cost of equity capital of the treated firms. We explore the underlying mechanism and find that this new evidence is present only in financially constrained firms. Further, the most impacted firms are those that enter the shock period with more need of external financing and those with post-shock increase in debt financing and debt maturity. We also find that increased institutional holdings and improved information quality (i.e. a decrease in analysts forecast dispersion) are channels through which stronger creditor rights decrease the coast of equity financing. Our findings provide supportive ground to the introduction of laws or regulations that strengthen the rights of other stakeholders.

Creditor Rights, Technology Adoption, and Productivity: Plant-Level Evidence

AbstractI use U.S. Census microdata to analyze the effect of stronger creditor rights on productivity. Following the adoption of antirecharacterization laws that give lenders greater access to the collateral of firms in financial distress, treated plants’ total factor productivity increases by 2.6%. This effect is concentrated among plants belonging to financially constrained firms. I explore the underlying mechanism and find that treated plants change the composition of their investments and their workforce toward newer capital and skilled labor. My results suggest that stronger creditor rights relax borrowing constraints and help firms adopt more efficient production technologies.

Highly Liquid Mortgage Bonds Using the Match Funding Principle

We show that pass-through funding of mortgages with covered bonds supported by strong creditor rights is one way of providing highly liquid mortgage bonds. Despite a 30% drop in house prices during the 2008 crisis, these mortgage bonds remained as liquid as comparable government bonds with high trading volume and low bid-ask spreads. Market liquidity of these covered bonds is primarily driven by the availability of funding liquidity. Funding liquidity is the main concern because the pass-through funding approach effectively eliminates other types of risks from the investor’s perspective. Banking regulators should take into account the implications of these findings, particularly when it comes to the interplay between liquidity and capital requirements.

Banking Relationships and Creditor Rights

Do the legal rights of creditors influence whether the firms borrow from arm’s length or relationship lenders in a country? We examine this question by exploiting the staggered adoption of legal reforms that changed creditor rights. We find that as creditor rights strengthen, firms exhibit a greater propensity to switch to relationship lenders. Conversely, firms switch to arm’s length lenders as creditor rights weaken. These results are consistent with the view that arm’s length creditors have a bias toward excessive liquidation in environments with strong creditor rights. Hence as creditor rights strengthen, firms switch to relationship lenders as they are less likely to sub-optimally liquidate the firm when continuation is more efficient.

Banking Relationships and Creditor Rights

Do the legal rights of creditors influence whether firms borrow from arm's length or relationship lenders in a country? In this paper, we examine this question by exploiting the staggered adoption of legal reforms that changed creditor rights. We show that as creditor rights strengthen, firms have a greater propensity to switch to relationship lenders. Conversely, firms switch to arm's length lenders as creditors rights weaken. The results are consistent arm's length creditors having a bias towards excessive liquidation in environments with strong creditor rights. Relationship lenders are less likely to sub-optimally liquidate a firm when continuation is more efficient. We find further support for this interpretation in results that show more pronounced effects for firms expected to suffer a greater value loss from inefficient liquidation.